January 2013: From Appreciation to Market Correction

The new year kicked off with a brutal first month for investors. Will it be a typical market correction, or just a temporary dip?

In our commentary last month, we summarized the strong end-of-year performance and noted that many people had waited to sell profitable positions until the start of the new year. This was done largely for tax reasons. As a result the market struggled to advance further, and it was left vulnerable to a correction. Like many such phases, a trigger is needed to begin the process. There were several.

On a one-month basis, it was a terrible showing for the Dow Jones Industrial Average (DJIA—15,698.85), which plummeted 5.3%. In fact, it was the worst monthly performance for DJIA since May 2012 (see chart). The broader S&P 500 Index (SPX—1,782.59) slid 3.6%, the Nasdaq Composite Index (COMPQ—4,103.88) dropped 1.7%, and the Russell 2000 Index (RUT—1,130.88) plunged 2.8%.

Problems in the emerging markets, as well as concerns about slowing growth in China, were the major catalysts for the selloff. Additionally, some US companies have reported weaker-than-expected quarterly results or made comments that growth in the future may not be so robust. The media has also focused on both the tapering by the Fed and the change at the helm for that policy making body.

There were some other anecdotal concerns, such as security during the Sochi Olympics. Sensitivity to news, especially bad news, has been on the rise.

Bundle it all together and you get a correction. The big question is will this be a traditional correction of 10% or more, or a non-traditional correction, like we have seen in the past year, that measured between 4% and 7%?

Commodities Are A Mixed Bag

Precious metals rebounded and then began to turn lower once as some investors targeted them as a "safe haven." Gold rose 3.3% in January while silver declined 1.5%. Expectations of an economic slowdown resulted in a 5.9% drop for High Grade Copper Feb 14 Futures (HG/G4—$3.21) and the lumber contract sank 3.3%.

Energy prices began the month by dropping and picked up during the second half of the month, largely due to unseasonably cold temperatures across most of the country. Crude Oil Mar 14 Futures (CL/H4—$98.64) initially dropped but ended the month down only 1.3% but the same contract for natural gas (NG/H4—$4.90) soared 16.7%.

Weather caused some agriculture prices to rise. Oats, soybeans, coffee, cocoa, and cotton were on the rise, and not just from the threat of cold. A sustained drought in California is putting pressure on farmers and their crops.

Currencies

The US Dollar Index (DXY—81.37) rose 1.4%, partly due to demand from investors and consumers in some of the emerging market countries looking to protect their assets. The "greenback" advanced against the Euro, British Pound, Canadian Dollar, Swiss Franc, Hong Kong Dollar, and Australian Dollar.

The Fed

Tapering continues at the Federal Open Market Committee (FOMC) as leadership changes. The Fed has been easing its foot off the proverbial stimulus gas pedal. However, despite what some believe to be as a tightening move, which it is not, yields dropped as investors moved into treasuries seeking safety. The CBOE 10-year T-note Yield Index (TNX) indicates a rate of 2.668%, down from 3.026% at the end of the year.

The Economy

There are signs that the economic growth engine is slowing, both domestically and internationally. In December only 74,000 new jobs were created, the slowest growth in three years. January's numbers were not available at press time. The first release on 4Q Gross Domestic Product (GDP) showed that the annual growth rate was 3.2%, down from 4.1% for 3Q. The consensus forecast was also for a gain of 4.1%, disappointing economists.

Retail spending was relatively active in December but analysts are speculating that January may not have been so good. The Advanced Monthly Retail Sales Report for December showed that spending rose only 0.2% month/month and 4.1% on a year/year basis. On the positive side, the Consumer Confidence Index for January rose to 80.7 from 77.5 in December. Hard economic numbers for January may be impacted by snow and extreme cold temperatures that gripped the country. This was illustrated by the 3.1% drop in US auto sales.

Equities, A Deeper View

The internal market indicators that we monitor are rolling over. The number of new highs on both the NYSE and Nasdaq have been shrinking. Our advance-decline indices, along with their volume weighted equivalents, have turned lower.

Risk perception has been rising sharply and traders are pricing in higher risk. The CBOE S&P 500 Implied Volatility Index (VIX), commonly known as the "fear gauge," rose to 21.48 on February 3rd, the highest reading since late June (see chart). VIX is a forward looking indicator, based on the percep-ion of risk over the next 30-days.

What To Watch For

We believe that the market is in a long awaited and overdue correction. The question is will it become a traditionally defined correction, with the benchmarks dropping more than 10% from their highs, or will it be an untraditional correction of less than 10%? The later is dismissed by some analysts since it does not meet the long observed definition of "correction."

The market is more sensitive to news, especially negative news. This may hold back any significant rallies and make the market vulnerable to pull-backs.

Despite the equities markets performance, the credit markets remain relatively stable, which should provide the base for continuation of the bull market. We remain positive and constructive over the intermediate-term to long-term horizon but our short-term outlook has become very defensive.

During the next month we will be watching several items, including the increase of the debt ceiling, consumer spending and confidence, economic growth both domestically and globally, and confidence levels.

Michael J. Levas has been in the investment management business for over 25 years and is the founder, senior managing principal & chief investment officer at the Olympian Group of Investment Management Companies. Prior to Olympian, he was a VP and Portfolio Manager in the ... View Full Bio